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State of the market: Everybody is wrong sometimes

The first words of the conversation definitely got my attention. After confirming that he did in fact have the guy making the decisions on the market, the caller, in a not-so friendly tone, bellowed into my ear, “You were wrong!” Although this assault was likely designed to get a charge out of me, I decided to be diplomatic and replied, “Could you be more specific?”

I quickly proceeded to explain that in the business of investing other people's money, we are “wrong” somewhere in our portfolios each and every day. Even in the most rip-roaring bull markets, you are bound to have a position or two scattered amongst your holdings that isn't behaving as you'd like. As such, being “wrong” is just part of the job description. Good investors learn to deal with this issue and have a plan to deal with being “wrong,” while beginners let red numbers define them and/or make them feel dumb.

It turns out that this particular caller was upset that in our Daily Decision strategy for the U.S. stock market, we had exited our long positions on Tuesday only to then re-enter them (albeit in a lower beta fashion) on Wednesday. Given that (a) it was possible that a new “spring crisis” was brewing, (b) the market had traded rather spastically over the last two days, (c) everyone on the planet had been calling for a meaningful correction (something that has happened every spring for like a decade running), and (c) we had locked in a nice gain on the position we sold, I didn't really understand the problem.

Even after the caller explained that we had gotten whipsawed by buying higher than we had sold the day prior, I struggled to understand why he was upset. After all, we had “missed” just one day and the DJIA had advanced just 56 points during our time-out. I proceeded to explain that when our Market Environment Model (which is designed to tell us, as you might suspect, which team the current market environment favors) is neutral, we utilize a short-term trend following strategy in this program. I then added that during these neutral, or what I like to call “iffy” times, our objective is to try and stay on the right side of the short-term trend. “The goal” I said, “is to be there when the next big, important move happens in the market.” I finished by patiently outlining the fact that the trade-off for “being there” when the next big move begins is that we will get whipsawed during these “neutral” market environments. “It's just part of the deal,” I said.

To my utter amazement, the man told me, and in no uncertain terms, that he wasn't paying me to be wrong. “You are a professional. You are experienced. You say you understand the markets. So, get it right next time – or else.”

“Or else… what?” I asked.

“Or else, you get fired, that's what,” came the words on the other end.

Having had this, or some variation of this conversation a few times over the past twenty-five years, I decided to continue to be professional and polite (well, at least up until the time I told him to take his business elsewhere). I said, “Look, while I don't want to suggest that your point of view is wrong, you do understand that the stock market is tricky, right?” Without pausing, I continued. “I've been at this a very long time and I've made my share of mistakes, but following a disciplined approach isn't one of them. As I explained a moment ago, when the market is overbought and the risk of a correction is high, our systems are designed to take less risk. So, if the short-term trend breaks down, we move to the sidelines. And then if the market rebounds, we jump back in.”

I went on to explain that such an approach may “sound” dumb or maybe even “wrong” but that there is simply no way on earth to be right all the time. “The overall goal” I added, “is to get the majority of the big moves right. And this is what our strategy is built for.” I then went for the big finish. “I can tell you with absolute certainty that we WILL be “wrong” from time to time. I know for a fact that we will look “dumb” on occasion. And experience has taught me that this is okay – as long as you are getting the bigger moves right.”

Dave Moenning

David Moenning is Chief Investment Officer at Heritage Capital Management, a Chicago-based registered investment advisory firm. Mr. Moenning began his investment career in 1980 and formed Heritage Capital in 1989. Dave’s firm focuses on “active management” and focuses on managing market risk on a daily basis. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Mr. Moenning is the 2013-14 President of NAAIM (National Association of Active Investment Managers) an organization dedicated to active management strategies. Follow Dave on Twitter at @StateDave.